nonbanks in the payments system terri bradford matt davies stuart e. weiner Copyright ©2003 Federal Reserve Bank of Kansas City. All rights reserved. Printed in the United States of America. No part of this publication may be reproduced in any form or by any means without the prior written permission of the authors, nor be otherwise circulated in any form of binding or cover other than that in which it is published. ISBN: 0-9744809-1-6 Payments System Research Federal Reserve Bank of Kansas City 925 Grand Blvd. Kansas City, MO 64198, USA This book can be obtained in electronic form from the Federal Reserve Bank of Kansas City’s Web site, located at http://www.kc.frb.org, under Publications & Education Resources. The views expressed in this book are those of the authors and do not necessarily reflect those of the Federal Reserve Bank of Kansas City or the Federal Reserve System. Foreword Nonbanks have always been a key component of the nation’s payments system, contributing to the breadth and competitiveness of the industry. In recent years, however, nonbanks have become even more prominent. As the nation’s central bank, it is important that the Federal Reserve track and analyze major developments in the payments system, including the rise in nonbank participation. This book represents an important step in gaining a better understanding of nonbanks in the payments system. It examines nonbank participation along two dimensions: the payments activities in which nonbanks are involved and the roles nonbanks play in specific transaction types. The analysis identifies 35 distinct activities in which nonbanks have a market presence and nearly 30 transaction types in which nonbanks play a role. It also addresses a number of risk considerations. The book presents several findings. Nonbanks are pervasive, both in traditional and emerging payments areas. Nonbank business relationships with banks and other participants in the pay- ments system are often highly complex and interrelated. Nonbanks are rarely directly involved in settlement activities and, hence, to date appear to be associated with limited settlement and systemic risk. But nonbanks and banks alike are increasingly susceptible to operational risk factors. It is likely that nonbanks will become even more prominent in the payments system in the future. Technological advances, increased outsourcing, and the steady shift from paper to electronics all are working to create a myriad of new market opportunities. Nonbanks undoubtedly will con- tinue to play a major role in this dynamic environment. It is the intent of this book to shed some light on such events as they unfold. Thomas M. Hoenig President and Chief Executive Officer November 2003 iii Acknowledgements We wish to thank numerous individuals for their assistance in the writing and publication of this book. Senior management, especially Tom Hoenig, Rich Rasdall, Enis Alldredge, Roberta Hearn, and Barb Pacheco, made available the resources and provided guidance for this and related proj- ects. Industry contacts who provided valuable insight and information included Jody Bomgaars, Adam Coyle, Nancy Grant, Steve Ledford, Danita Gibson Lloyd, Randy McCartney, Tom Murphy, Todd Pearson, Dave Stewart, Paul Tomasofsky, and Margaret Weichert. And we thank colleagues throughout the Federal Reserve System and the Bank—with special recognition of the Bank’s Public Affairs Department—for their important contributions. Terri Bradford Payments System Research Specialist Matt Davies ACH Specialist Stuart E. Weiner Vice President and Economist v Contents 1 Introduction .................................................................................................................... 1 2 Overview Nonbank payments activities.................................................................................... 3 Payments system risks............................................................................................. 9 3 Nonbank Roles in Traditional Payments Types Introduction ............................................................................................................ 13 Check..................................................................................................................... 15 ACH ....................................................................................................................... 21 Credit card and offline debit card............................................................................ 23 Online debit card .................................................................................................... 27 Retail wire services ................................................................................................. 29 4 Nonbank Roles in Emerging Payments Types Introduction ............................................................................................................ 31 Check conversion Point of sale (POS).......................................................................................... 33 Lockbox ......................................................................................................... 39 Electronic bill presentment and payment (EBPP) .................................................... 42 Electronic invoice presentment and payment (EIPP) ................................................47 Person-to-person (P2P).......................................................................................... 49 Stored value ........................................................................................................... 54 Contactless payments............................................................................................ 61 5 Summary....................................................................................................................... 63 Endnotes....................................................................................................................... 65 Glossary of Terms........................................................................................................ 69 References ................................................................................................................... 73 Index ............................................................................................................................. 75 vii Tables, Charts, and Figures Table 1: Nonbank Payments Activities .................................................................................... 5 Chart 1: Nonbank Roles in Traditional Payments .................................................................. 14 Figure 1: Check: POS—Without Truncation .......................................................................... 17 Figure 2: Check: POS—With Truncation ............................................................................... 18 Figure 3: Check: Lockbox—Bank as Processor.................................................................... 19 Figure 4: Check: Lockbox—Nonbank as Processor.............................................................. 20 Figure 5: ACH....................................................................................................................... 22 Figure 6: Credit & Offline Debit: Card Present—Visa/MasterCard Networks.......................... 24 Figure 7: Credit & Offline Debit: Card Present—First Data Network....................................... 25 Figure 8: Credit & Offline Debit: Card Not Present................................................................. 26 Figure 9: Online Debit ........................................................................................................... 28 Figure 10: Retail Wire Services.............................................................................................. 30 Chart 2: Nonbank Roles in Emerging Payments .................................................................. 32 Figure 11: Check Conversion: POS—ACH ........................................................................... 35 Figure 12: Check Conversion: POS—EFT............................................................................. 36 Figure 13: Check Conversion: POS—Visa (in network) ......................................................... 37 Figure 14: Check Conversion: POS—Visa (out of network) ................................................... 38 Figure 15: Check Conversion: Lockbox—Bank as Processor ............................................... 40 Figure 16: Check Conversion: Lockbox—Nonbank as Processor ......................................... 41 Figure 17: EBPP: Biller Direct................................................................................................ 44 Figure 18: EBPP: Consolidator ............................................................................................. 45 Figure 19: EBPP: Lockbox.................................................................................................... 46 Figure 20: EIPP: Consolidator ............................................................................................... 48 Figure 21: P2P: PayPal—Sending......................................................................................... 51 Figure 22: P2P: PayPal—Receiving....................................................................................... 52 Figure 23: P2P: Western Union MoneyZap ........................................................................... 53 Figure 24: Stored Value: Single Purpose—Sale....................................................................